Demographics is arguably the most underestimated force in the world of economics and finance. Changes in the ratio of younger to older workers and retirees have sharply altered the metrics that underpin key social programs such as Social Security and Medicare over many decades, thereby ripping vast holes in the Federal budget. A study by the Federal Reserve Bank of San Francisco demonstrates how demographics also could impact the U.S. equity market in coming years.

Of course, the aging of America has long been cited as a looming headwind for stocks. In particular, the 77 million baby boomers are expected to convert some of their holdings from equities to bonds to finance retirements that might stand on shaky ground after years of conspicuous consumption and inadequate savings. The Fed report uses historical data to show the effect this might have on the relationship between earnings and stock prices.

Since the mid-1950s, the inflation-adjusted, year-end price-to-earnings (PE) valuation of the S&P 500 has closely tracked the age distribution of the domestic workforce, as measured by the middle-age cohort (age 40-49) to the old-age cohort (age 60-69). Unlike other similar studies (check the footnotes that accompany the study), the authors use the mid-to-old rather than the mid-to-young ratio because Americans in their sixties are thought to have a larger impact on demand for financial (rather than real) assets than do those in their twenties and thirties.

“Since demographic trends are largely predictable,” the authors assert, “we can forecast the path that the P/E ratio is likely to follow in the next few decades based on the predicted [ratio of middle-aged to older Americans].” Their forecast isn’t likely to ignite your animal spirits. The Fed model sees the inflation-adjusted P/E ratio dropping from 15 in 2010 to 8.3 in 2025 before recovering to about 9 by 2030. If real (inflation-adjusted) earnings grow at the long-term average of 3.42% annually, presumed changes in the P/E ratio would cause stock prices to decline 13% between 2010 and 2021 before rebounding strongly through 2030.

With the Fed printing dollars by the trillions since the report was written in 2011, equity market valuations and prices have not adhered to the downward path suggested by the M/O ratio. Apparently, the power of newly minted money trumps even that of demographics.